Do Lawmakers Really Understand the Energy Markets?


"Directly comparing today's oil price to supply over the longer term. . .ignores the effects of inflation."

Last week, the U.S. Federal Trade Commission (FTC) issued new rules to prevent oil market manipulation. It will now coordinate its efforts with the Commodity Futures Trading Commission (CFTC) to police the physicals and futures markets.

The FTC's new rules prohibit oil market participants from making misleading statements or intentionally omitting information that could affect prices.

In advocating for tougher regulations, Sen. Maria Cantwell (D-Wash.), a member of the Senate's Energy and Natural Resources Committee, said this year's hike in oil prices raised questions about manipulation of the markets.

"Oil supplies are near 20-year highs," she said, "and demand for oil is at a 10-year low—so why have gasoline prices gone up a dollar a gallon since the beginning of the year?"

Why, indeed?

If we gauge the oil supply as the commercially available domestic stockpile outside the SPR, the senator's got a point. However, Cantwell has overlooked a lot of context by pitting the crude oil supply against gasoline prices.

Directly comparing today's oil price to supply over the longer term ignores the effects of inflation.

When oil supplies peaked in summer 1990, crude was ~$21 a barrel. Inflating the 1990 price by the CPI makes the oil worth $34 in 2009 dollars. Inflation accounts for 42% of the apparent price rise since oil's last supply peak.

And the rest? We can determine the legitimacy of oil prices by looking at the futures curve. When we're well-supplied with oil, contracts for later delivery are priced higher than the spot market (i.e., contango).

Oil's flip to contango in June 2008 presaged the post-Independence Day plummet that took prices down $111 a barrel by year's end. Fully a month before crude tumbled from nosebleed heights, the market was signaling slackening demand, and the prospect of a supply overhang.

Over the past two decades, the crude oil market's vacillations between contango and backwardation line up pretty well with oil inventories.

We're in a contango now, meaning we have more oil than we need. But the contango's not huge by any means.

I'm not saying that there hasn't been manipulation, I wonder just how well lawmakers understand the markets' seasonal and demand influences.

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